A power imbalance gets in the way of setting smart policy on donor-advised funds

Here’s an idea: Let’s agree to stop referring to "the nonprofit world."

That’s because, in reality, there are two nonprofit worlds.

The first is made up of the hundreds of thousands of charitable organizations that provide actual services. The second is made up of foundations, donor-advised fund sponsors, and corporate and individual donors.

The priorities of these two nonprofit worlds are different.

The first nonprofit world — I’ll call it "the charities" for short — is focused on meeting various missions: feeding, housing, educating, and counseling people; saving the earth and animals; curing diseases and healing the sick; producing community theater and running art classes; rescuing, feeding, and supporting families displaced from natural disaster; and generally doing whatever possible to keep this frayed and fragmented society of ours from falling to pieces.

The second nonprofit world — "the grant makers" — genuinely cares about all of that. But the grant makers are also concerned with their own institutions’ and donors’ well-being, tax advantages, budgets, and privileges. And the interests of the grant makers are often in conflict with those of the charities.

There is a significant power imbalance between the two nonprofit worlds.

This would seem to be an obvious point, but it’s one that generally is not acknowledged, at least not publicly. Charities need money. Grant makers have money, and consequently, they have all the power in the relationship. I know very few grant makers who consciously lord it over charities, and most grant makers would be sincerely upset to think they do so.

But inequality is baked into the relationship. Grant makers can and do tell charities how to do their work. Charities never tell grant makers how to do theirs. Or if they do, it’s in a whisper, and at their peril.

What Charities Hate

This power imbalance and the conflicting interests of the two nonprofit worlds came to light in a pair of letters sent to the Senate Finance Committee over the last few months.

The topic was donor-advised funds and whether the federal government should change the rules governing their operation. This is a hot topic because donor-advised funds — and the Wall Street firms that run many of them — have distorted charitable giving in America and changed the face of philanthropy.

But let’s also recognize that donor-advised funds lie on the fault line between the two nonprofit worlds: grant makers love them while charities hate them. The exchange of letters highlighted in the Chronicle article demonstrates the power that grant makers hold over how the interests of nonprofits get advanced in Washington. Virtually no nonprofit associations — not even Independent Sector, an organization whose explicit mission is to represent all nonprofits — publicly speaks on behalf of the charities.

The first letter was sent in July by Ray Madoff and Roger Colinvaux, professors of law at Boston College and Catholic University, respectively, to the Senate Finance Committee.

Ms. Madoff and Mr. Colinvaux made two recommendations regarding donor-advised funds. The first is to introduce a requirement that money in donor-advised funds be distributed to charities within a fixed number of years after being contributed.

This proposal speaks to the frustration of charities that there is no spending requirement whatsoever for donor-advised funds; once the gift is made (and once it has earned a charitable tax deduction for the donor), the money can literally sit in a DAF forever. Ms. Madoff and Mr. Colinvaux are essentially advocating that the money be required to pass from the grant makers to the charities within a certain number of years.

Skirting the Law’s Intent

The authors’ second recommendation is that grants to donor-advised funds not be allowed to count toward the annual 5-percent distribution to charities that private foundations are required to make.

Why does this matter?

Because foundation grants to DAFs make a mockery of current law. The federal government requirement that foundations distribute at least 5 percent of their assets each year for charitable purposes stems from the 1969 Tax Reform Act.

That legislation set up different types of regulation to govern foundations and charities.

Congress clearly wanted to keep its eye on foundations, which typically remain under the control of donors and their families, and thus are more easily manipulated for personal benefit. Congress was essentially saying: We don’t really trust foundations, so a) we want money to go out the door every year, and b) we want every grant (and other financial information) to be subject to public scrutiny.

Donor-advised funds give foundations a way of technically meeting the 5-percent distribution requirement while essentially hiding their grant making from public view.

This is how it works: A foundation sets up a donor-advised fund with its own trustees as the controlling advisers. The foundation then makes a grant to the donor-advised fund. Because the donor-advised fund is part of a public charity (the sponsoring organization), that grant qualifies as a charitable distribution, thereby helping the foundation meet its 5-percent distribution requirement. But from that point on, the public has no idea where the money eventually goes, or even if it goes to a charity at all. This scheme clearly undermines the intent of the 5-percent distribution rule for foundations.

In their letter, Ms. Madoff and Mr. Colinvaux essentially came down on the side of the charities. They advocated that money be required to pass from donor-advised funds (the grant makers) to operating nonprofits (the charities) within a reasonable period of time, and that foundations (again, the grant makers) stop playing games by making grants-that-aren’t-really-grants to donor-advised funds.

The authors identified legitimate problems with donor-advised funds, and they offered reasonable solutions. But that did not play well with grant makers. A few weeks later, a coalition of four organizations sent a 12-page response to the Senate Finance Committee. In a tone that I would describe as vehement and belittling, the letter declared that the Madoff-Colinvaux proposals were "misguided and misleading" and "harmful."

Representing Grant Makers

So who are the forces that wrote this angry response?

Three of the groups clearly represent the grant makers. The first is the Council on Foundations, whose community-foundation members rely on donor-advised funds as the group’s most popular product. The second group in the coalition, the Community Foundation Public Awareness Initiative, is not an organization at all but a Washington lobbying effort funded by, and working on behalf of, community foundations. (According to OpenSecrets.org, the lobbying firm Van Scoyoc Associates has received more than $2.3 million for this effort since 2012.) These two groups represent the interests of community foundations, whose goal, narrowly defined, is to maintain the status quo on rules governing donor-advised funds. The third organization, the Philanthropy Roundtable, also represents grant makers, though it is more ideologically driven, using philanthropy to promote conservative causes. The organization has historically advocated for the unfettered use of donor-advised funds, a position in line with its philosophy that any government regulation of charitable activities undermines private initiative and the public good.

Independent Sector’s View

The fourth and most troubling member of this coalition is Independent Sector, which claims to represent both grant makers and charities.

Donor-advised funds are an issue over which Independent Sector’s members are utterly divided: the grant makers (particularly DAF-sponsoring organizations) love them, and charities (quietly, but utterly) resent them. I would have assumed that, given the breadth of its membership, Independent Sector would have sat out this fight. But instead, Independent Sector publicly took a stand alongside the grant makers.

I doubt that Independent Sector made much of an effort to understand the charities’ point of view on this issue.

If it had, Independent Sector would have learned that many charities are aghast at the growth of the donor-advised fund industry and the way DAFs now dominate the listing of the country’s largest fund-raising organizations. It would have found that charities consider the profit motive driving the explosive growth of commercial DAFs to be morally troubling.

It would have discovered that charities feel undermined by the way DAF sponsors and the financial services industry have a vested interest not only in attracting gifts to donor-advised funds but also in keeping the money invested, rather than distributing it for charitable purposes.

And Independent Sector would have learned that donor-advised funds have added complexity to relationships between nonprofits and their donors, particularly related to accepting gifts for multiyear pledges, gala tickets, and other charitable commitments.

I’m not surprised that the Council on Foundations, community foundations, and the Philanthropy Roundtable attacked suggestions for reforming donor-advised funds. These are organizations whose mission is to protect the interests of grant makers. But for Independent Sector to jump in with both feet on this issue was both sad and illuminating. Independent Sector should know better, and if it truly represented charities as well as grant makers, it would know better.

Fidelity’s Stunning Growth

The coda to this exchange was the stunning, but not surprising, news that Fidelity Charitable — already the top fund-raising "charity" in the country — experienced a 68-percent jump in contributions in its most recent fiscal year, to $6.85 billion.

That news is yet another indication that something is askew in philanthropy; that far too much money is going into, and remaining in, donor-advised fund accounts, and that the recommendations of Ms. Madoff and Mr. Colinvaux might, in fact, be an effective way to recalibrate DAFs. (The authors, meanwhile, reemphasized their position last week in a convincing second letter to the Senate Finance Committee.)

Congressional staff members and journalists studying donor-advised funds would do well to recognize that there are two distinct nonprofit worlds, not one. They should understand that the public’s interest does not lie in supporting the preferences of the richest and most powerful grant makers and donors but rather in strengthening the charitable organizations that deliver vital services to the community. Perhaps, eventually, one or another organization that purports to represent the interests of nonprofits — which is to say, charities — will take a deep breath, stand up, and actually do just that.